Operating cash flow is generated through revenues, or the cash in, and through expenditures, or the cash out. But the speed at which sales are converted to cash and the speed at which your own suppliers are paid, has an important influence on the health of your operation. So it makes sense to be able to predict how much cash you'll have on-hand in the future.
Start with a balance sheet
If you're starting a new business, you'll be investing your own money (equity) and incurring some liabilities (purchasing inventory and or machinery on credit or borrowing money from a lender). At that point in time, the company's total assets (or value of goods or infrastructure you've purchased) will be equal to the money you've invested (the equity) and the money you have borrowed.
The formula looks like this: Total Assets = Liabilities + Equity
The balance sheet however, does not show when you will have to make payments on purchased equipment or taxes payable such as GST. Those taxes come due in the future, so it's a good idea to plan or budget for them ahead of time.
Track operating cash flow through income statements
If the balance sheet is a snapshot of your business at a certain point in time, the income statement shows what really happened with your sales and expenses over a period of time in the past. If you have monthly income statements, you may be able to identify patterns in your business cycle and help you make projections for the future.
Generate a cash flow budget
Using your projected balance sheet and projected income statement, you can create a projected cash flow budget in order to plan ahead. For a new business, cash flow projections may be more difficult to set up since there is no previous data, but data for related businesses can be found through industry groups, from your banker, your accountant and even over the Internet.
For cash inflows, you need to make sure you account for all possible sources of income including tax refunds, grants, sales of assets as well as sales of goods and services. Your cash outflows include operating expenses such as salaries and rent, debt and tax payments as well as the cost of the goods sold. At the end of every period, you should have a closing cash balance which then becomes the opening cash balance for the next period.
The budget should be realistic enough so that you can see whether you need more working capital financing. It should be detailed enough to indicate those periods where revenues may be lower than expenditures. Finally, it should prompt you to create an action plan for dealing with cash flow surpluses as well as cash crunches.
For instance, you can identify periods where your sales are low and plan to bridge the gap by increasing your line of credit in advance. For a projected large order where you need to suddenly increase your inventory without getting paid right away, you may want to arrange for long-term working capital financing. You may also notice that you are paying suppliers in less time than it takes to get paid by your customers. If that's the case, you might want to negotiate better terms with those suppliers. And if it's taking longer to get paid by your customers, it may be time to build some early-payment inducements into your operation.
Get the whole story
Your success in business will be influenced by sales, control of expenses as well as by getting the right long-term financing for asset purchases. By comparing cash flow projections with what actually happened over a period of time, you will gain insight into your operation that will help you establish strategies for growing the business.
But while cash flow projections and statements are important tools for managing your company, they don't necessarily reveal all the important information that you need. For instance, the income statement won't tell you how long it takes to make a sale or how many potential customers you had to contact before making that sale.
If you need help analyzing or gathering that information, the BDC provides affordable consulting services that can help you manage your inventory, track your receivables and improve your cash flow.
